The U.S. Trustee Program's Efforts to Prevent Bankruptcy Fraud and Abuse

Report No. 03-17
March 2003
Office of the Inspector General

BACKGROUND

Authorities

The Bankruptcy Reform Act of 1978 (11 USC § 101, et seq.) established a pilot U.S. Trustees Program to correct conflicts of interest and enhance the integrity of the bankruptcy system. The Bankruptcy Judges, U.S. Trustees, and the Family Farmer Bankruptcy Act of 1986 expanded the Program from a pilot effort involving 18 districts to a permanent national effort involving 21 regions with offices that mirrored the federal judicial districts.5

According to its mission statement, the UST Program is designed to:

promote the efficiency, and protect and preserve the integrity of the bankruptcy system;

work to secure the just, speedy, and economical resolution of bankruptcy cases;

monitor the conduct of parties and take action to ensure compliance with applicable laws and procedures;

identify and investigate bankruptcy fraud and abuse; and

oversee administrative functions in bankruptcy cases.

Title 11 of the U.S. Code, known as the Bankruptcy Code (Code), and the Federal Rules of Bankruptcy Procedure govern bankruptcy filings. There are two basic types of bankruptcy filings: liquidation under Chapter 7 of the Code and rehabilitation of the debtor under Chapters 11, 12, and 13. According to the United States Bankruptcy Court, there were 6.9 million bankruptcy filings under these four chapters for calendar years 1997 through 2001. The trend in bankruptcy filings is upward. New bankruptcies filed during the second quarter of 2002 and for the previous 12 months set all-time records. New filings for a 12-month period ending June 2002 reached 1.5 million for the first time. The majority of bankruptcies are filed under Chapter 7 of the Code.

Bankruptcy Chapters and Filings

Debtors may file for relief under one of four Chapters of the Code: Chapter 7 involves the liquidation of personal or business assets to satisfy debts; Chapter 11 is used by businesses that want to continue operating while paying debts; Chapter 12 allows family farms to continue operating while paying debts; and Chapter 13 allows wage earners to reorganize their financial affairs under a repayment plan. The four Chapters are described in greater detail below.

Over the past five calendar years, the number of bankruptcy filings of all types has exceeded six million. The following table shows the number of filings by bankruptcy Chapter for each year. In 2001, total bankruptcies filed reached an all time high, increasing 19 percent (238,669) over 2000. Bankruptcy filings increased for all chapters except Chapter 12, which decreased by about 6 percent (24). The largest increase, about 23 percent (195,755), was in Chapter 7 filings. Partial data for 2002 indicates that the rate of bankruptcy filings continues to increase, reaching about 1.5 million new filings over a 12-month period ending in the second quarter of 2002.

Bankruptcy Filings by Chapter of the Bankruptcy Code
Calendar Years 1997 through 2001

Year

Chapter 7

Chapter 11

Chapter 12

Chapter 13

Total

1997

989,372

10,765

949

403,025

1,404,111

1998

1,035,696

8,386

807

397,619

1,442,508

1999

927,074

9,315

834

382,214

1,319,437

2000

859,220

9,884

407

383,894

1,253,405

2001

1,054,975

11,424

383

425,292

1,492,074

Total

4,866,337

49,774

3,380

1,992,044

6,911,535

Source: United States Bankruptcy Court

Chapter 7 of the Code allows the liquidation (sale) of personal or business assets to pay debts. In a Chapter 7 liquidation proceeding, assets that are not exempt from creditors by law are collected and sold. A private trustee appointed by a U.S. Trustee to administer the debtor's estate distributes the proceeds to creditors. An eligible debtor may receive a discharge from his or her debts under Chapter 7, except for any debts that are prohibited from discharge by the Bankruptcy Code such as taxes, child support, and alimony payments. As shown in the table above, the vast majority of bankruptcy filings are under Chapter 7 (70 percent of bankruptcy filings in 2001), although Chapter 13 results in almost twice as many dollars collected from debtors.

According to UST Program information, between calendar years 1994 and 2000, the total amount of receipts collected for Chapter 7 bankruptcy cases was $10.5 billion. UST Program officials were unable to provide us with the total of the original debt. As shown in following chart, 60 percent of the receipts over the seven-year period, or $6.3 billion, was distributed to creditors. The remainder of the receipts covered administrative and prior bankruptcy chapter costs, costs of trustees and their firms, fees of professionals, and other disbursements (including surplus funds returned to debtors, non-estate funds paid to debtors or third parties, and debtor exemptions).

According to UST Program information, historically 95 percent of Chapter 7 cases are cases where no money is returned to creditors. These cases are commonly known as "no-asset" cases. Chapter 7 private trustees receive $60 for administering a "no-asset" case. In cases where money is returned to creditors (asset cases), the Chapter 7 trustees may receive substantial fees for administering the case. In asset cases, trustees received the $60 plus compensation for services rendered as trustee.6

Chapter 11 of the Code allows a debtor, usually a business, to pay debts while continuing to operate. The debtor, often with the participation of creditors, creates a reorganization plan allowing the repayment of all or part of the debt. The debtor may generally continue business operations pending reorganization, unless the court orders the appointment of a trustee. In Chapter 11 cases the USTs are responsible for appointing and convening the creditors' committees and reviewing monthly operating reports. Chapter 11 filings were less than one percent of total bankruptcy filings in 2001. Information on collections and disbursements under Chapter 11 was not readily available in UST Program information. Chapter 11 debtors are required to pay quarterly fees to the UST Program until the case is closed, dismissed, or converted to another Chapter. The Chapter 11 debtor pays between $250 and $10,000 to the UST Program based on the total amount disbursed during the quarter. If there are no disbursements made during the quarter, the minimum fee of $250 must still be paid. For FYs 1997 to 2001, the UST Program collected $361 million in quarterly fees, an average of $18 million per quarter.

Chapter 12 of the Code allows eligible family farms to file for bankruptcy, reorganize the farm's business affairs, continue operating, and repay all or part of the farm's debts. In 2001, the number of
Chapter 12 filings represented an inconsequential fraction of a percentage of total bankruptcy filings. From FY 2001, the Chapter 12 trustees collected $39.7 million in debtors' payments, of which $31.3 million was paid to creditors. The remaining $8.4 million was distributed to Chapter 12 trustees for compensation, administrative expenses, and professional fees. A private trustee appointed by a UST typically serves as the trustee of the debtor's estate pending fulfillment of the debtor's repayment obligations under a plan confirmed by the U.S. Bankruptcy Court. A Chapter 12 trustee is compensated based on level five of the federal executive salary schedule or five percent of payments, whichever is less.

Chapter 13 of the Code allows individual wage earners (consumers) to reorganize their financial affairs under a repayment plan that must be completed within three to five years. To be eligible for Chapter 13 relief, a consumer must have regular income and may not have more than a certain amount of debt, as set forth in the Bankruptcy Code. About 29 percent of total bankruptcy filings in 2001 were under Chapter 13. However, collections of debtors' payments were almost twice as much as receipts collected under Chapter 7, although Chapter 7 had over twice as many bankruptcy filings. From FY 1994 through 2001, the Chapter 13 trustees collected $19 billion in debtors' payments, of which $15.4 billion was paid to creditors. The remaining $3.6 billion was distributed to Chapter 13 trustees for compensation, administrative expenses, and professional fees. A private trustee appointed by a UST typically serves as the trustee of the debtor's estate pending fulfillment of the debtor's repayment obligations under a plan confirmed by the Bankruptcy Court. Chapter 13 trustee compensation is similar to that of Chapter 12 trustees, described above.

UST Program Organization

The UST Program has three major organizational units: the Executive Office for U.S. Trustees (EOUST), 21 regional offices headed by USTs, and 95 field offices headed by Assistant United States Trustees (AUSTs).7 The following chart shows the organizational structure of the UST Program.

The EOUST, under a Director appointed by the Attorney General, provides general policy and legal guidance to the UST Program's regional and field offices in their implementation of federal bankruptcy laws and also oversees the UST Program's operations and administrative functions.

Each UST, also appointed by the Attorney General, is responsible for managing the field offices located within his or her region. Specifically, USTs are responsible for:

appointing and supervising private trustees who administer Chapters 7, 12, and 13 bankruptcy estates and directly serving as a trustee in cases where private trustees are unable or unwilling to serve;

taking legal action to enforce the requirements of the Code and preventing fraud and abuse;

referring cases for investigation and criminal prosecution;

ensuring that bankruptcy estates are administered promptly and efficiently and that professional fees are reasonable;

reviewing disclosure statements and applications for the retention of professionals such as attorneys; and

advocating matters relating to the Code and rules of procedure in court.

Responsibilities of Private Trustees

The UST appoints nearly all private trustees.9 As of March 2002, there were 2,665 private trustees nationwide. The following chart shows the number of private trustees by chapter.

United States Trustee ProgramTrustees As of March 2002

Chapter

Number ofTrustees

CHAPTER 7

1,544

CHAPTER 11

879

CHAPTER 12

54

CHAPTER 13

188

TOTAL

2,665

Source: EOUST

Chapter 7 Trustees

The principal responsibility of a Chapter 7 trustee is to collect and liquidate the property of a bankrupt estate and distribute the proceeds to creditors. According to the Code, Chapter 7 trustees' responsibilities are to:

collect and sell estate property and close the estate as expeditiously as possible;

oppose the premature discharge of the debtor (but not the discharge of a particular debt, since only the creditor to whom it is owed may do so);

furnish information concerning the estate and the estate's administration as requested by interested parties unless ordered otherwise by the court;

for authorized operating businesses of the debtor, file with the court, UST, or any governmental unit responsible for collecting or determining tax liability, periodic reports and summaries including statements of receipts and disbursements; and

file final reports (TFRs) and final accounts (TDRs) of the administration of the estate with the UST and the court.10

Chapter 11 Trustees

The court may direct the UST to appoint a Chapter 11 trustee upon the request of an interested party or the UST. A Chapter 11 trustee is appointed if:

management is accused of fraud, dishonesty, incompetence, or gross mismanagement either before or after the commencement of the case; or

such appointment is in the interest of creditors, any equity security holders, and other interests of the estate.

Chapter 11 trustees are to:

be accountable for all property received;

examine proofs of claims and object to the allowance of any improper claims;

furnish information concerning the estate and the estate's administration as requested by a party in interest, unless the court orders otherwise;

file with the court, UST, and any governmental unit with responsibility for collection or determination of any tax arising out of the operation, periodic reports and summaries of the operation of the business, including a statement of receipts and disbursements, and such other information as the UST or the court requires;

make a final report and file a final account of the administration of the estate with the court and the UST;

file the list, schedule,11 and statement if the debtor has not done so;

investigate the acts, conduct, assets, liabilities, and financial condition of the debtor, the operation of the debtor's business and the desirability of the continuance of the business, and any other matter relevant to the case or to the formulation of a reorganization plan;

file a reorganization plan, a report of why the trustee will not file a reorganization plan, or recommend conversion or dismissal of the case;

furnish, without personal liability, tax returns not filed by the debtor; and

file any report necessary or as the court orders after confirmation of a plan.

In lieu of appointing a trustee, the court may appoint an examiner to conduct an investigation of the debtor as appropriate. The investigation may include allegations of fraud, dishonesty, incompetence, misconduct, mismanagement, or irregularity in the management of the affairs of the debtor by current or former management. An examiner may be appointed if one of the two following conditions exists:

the appointment is in the best interest of creditors, any equity security holders, and other interests of the estate; or

Most Chapters 12 and 13 trustees are known as standing trustees. Their responsibilities are the same as Chapter 7 trustees except that they also:

appear at any hearing concerning the value of the property subject to a lien, confirmation of a plan, or modification of a plan after confirmation;

assist the debtor in executing the plan;

ensure that the debtor makes payments;

investigate the acts, conduct, assets, liabilities, and financial condition of the debtor, the operation of the debtor's business and the desirability of continuing the business, and any other matter relevant to the case or to the formulation of a plan if the debtor is engaged in business; and

disburse to creditors funds collected from debtors pursuant to the terms of the confirmed plan.

UST Program Funding and Expenditures

The UST Program is entirely funded by fees assessed against debtors who use the bankruptcy system. Fees established by statute are deposited in the U.S. Trustee System Fund (Fund). Revenue for the UST Program is also generated from interest on Fund balances invested in U.S. Treasury notes and bills, Chapter 7 case administration receipts, excess compensation of Chapters 12 and 13 trustees, and collections of outstanding receivables that have been referred to the Department of the Treasury for debt collection. The Congress appropriates a portion of the fees for use by the UST Program. For FY 2001, the UST Program deposited $151 million into the U.S. Trustee System Fund and was appropriated $126 million.

Two categories of fees generate most of the revenue for the fund. The first category, providing $61 million or 40 percent of the UST Program's funding in FY 2001, consists of fees paid by debtors at the inception of cases under Chapters 7, 11, 12, and 13. The second category, providing
$82.5 million or 55 percent of the UST Program's funding is the quarterly fees paid by Chapter 11 debtors. The other $7.4 million or 5 percent comes from miscellaneous compensation associated with Chapters 12 and 13, debt collection receipts, and refunds.

In FYs 1997 to 2002, the UST Program obligated about $739 million in total to manage and provide oversight of the bankruptcy system. The UST Program classifies the funds into two categories - Administration of Cases and Management and Administration. The Administration of Cases category includes the cost of administering all bankruptcy cases filed within the 95 field offices. The Management and Administration category includes the cost to maintain the EOUST in Washington. In FY 2002, the UST Program's budget increased nearly 21 percent over FY 2001. The following table shows the distribution of obligated funds between the two categories and the totals by year.

Funds Obligated by the UST ProgramFYs 1997 to 2002

Category

Administration of Cases

Management and Administration

Total

1997

$ 99,569,000

$ 8,202,000

$107,771,000

1998

$108,540,000

$ 9,001,000

$117,541,000

1999

$110,737,000

$ 8,872,000

$119,609,000

2000

$110,706,000

$10,843,000

$121,549,000

2001

$117,735,000

$ 8,750,000

$126,485,000

2002

$145,717,000

$0*

$145,717,000

Total

$693,004,000

$45,668,000

$738,672,000

Source: Obligations for FYs 1997 to 2001 according to UST budget documents, and obligated funding for FY 2002 according to UST Program officials.

* Per JMD guidance, as part of a Government Performance and Results Act initiative, the UST Program was directed to merge the Management and Administration decision unit into the Administration of Cases decision unit.

According to UST Program officials, for FY 2002 Congress appropriated $6.3 million to fund 104 positions for fraud and civil abuse initiatives, $3.7 million for 55 positions to address additional bankruptcy caseload, and nearly $2 million for 5 automation positions, hardware, and facilities security. In addition, the UST Program received an additional $2.8 million for mission-critical automation projects from the unobligated balances in the Department's Working Capital Fund.

For FY 2002 the UST Program had requested $7.8 million for a fraud and an abuse initiative, $7.3 million for hardware and software upgrades for the UST Program's Automated Case Management System (ACMS) and electronic case filing,12 and $3.7 million to deal with the increase in bankruptcy filings. Of the $7.8 million requested for fraud and abuse initiatives, $1 million was for a Bankruptcy Fraud Initiative and $6.8 million was for an Abuse Litigation Initiative. The purpose of the Bankruptcy Fraud Initiative was to establish a Bankruptcy Fraud Team, consisting of 12 new attorney positions, to serve each of the 11 judicial circuits and the Washington, D.C. area. The team was expected to help identify bankruptcy fraud and support the prosecutorial efforts of federal law enforcement authorities. The purpose of the Abuse Litigation Initiative was to hire 36 attorneys, 24 bankruptcy analysts, 24 paralegals, and 28 clerks to identify debtors abusing the bankruptcy system. The initiative will target those who file under Chapter 7 but who may have sufficient income to sustain a Chapter 13 repayment plan. The UST Program was in the process of hiring the additional staffing during our audit.

Training

UST Employees

The UST Manual emphasizes the need for UST personnel to be trained in the criminal aspects of bankruptcy law so that they may effectively respond to complaints, discover criminal activity, and promptly refer criminal matters to the proper authorities. In FY 1999, the UST Program established the National Bankruptcy Training Institute (Institute) located in
Columbia, South Carolina. The Institute's courses were designed with assistance from the American Bankruptcy Institute, National Association of Bankruptcy Trustees, National Bankruptcy Fraud Working Group, and law enforcement agencies. The Institute provides a three-day course on bankruptcy fraud and civil enforcement to AUSTs, Attorneys, Bankruptcy Analysts, and Paralegals. The course, entitled "Bankruptcy Fraud: Civil and Criminal Enforcement," covered:

overview of the criminal justice system,

uncovering evidence of fraud and abuse,

health care fraud and bankruptcy,

serial filers,

fraudulent petition preparers,

cooking the books, and

identity fraud.

As of February 2002, 421 of the 701 eligible employees, or 60 percent, had received fraud training. A detailed listing of the number of employees who received training, by regional office, is included in Appendix 5.

Panel and Standing Trustees

The UST Program requires that Chapter 7 trustees receive at least one hour of training on criminal fraud every three years. The training is to cover the basic criminal bankruptcy statutes and preparation of fraud referrals. The UST Program has not established a specific bankruptcy fraud training requirement for the other chapter trustees. However, the USTs at the five regional offices we audited provided annual bankruptcy fraud training to all trustees.

Prior Audit Reports and Studies

We identified and reviewed one prior Office of the Inspector General (OIG) report and one Departmental study related to certain aspects of this audit, primarily UST oversight of bankruptcy trustees. We did not identify any relevant reports by the U.S. General Accounting Office.

In the OIG's September 1992 audit report, "Monitoring of Private Trustees" (92-19), we reviewed the EOUST's and the UST's (1) reporting and monitoring of private trustees, and (2) follow up on private trustee deficiencies and indications of fraud. We found that the UST regions had procedures for monitoring private trustees' bonding, reporting, and case closing and for following up on Chapter 7 reviews. However, the quality of monitoring varied by region and sometimes among field offices within regions. We concluded that the EOUST had limited assurance of trustee propriety because its oversight of trustee reviews and audits needed improvement. The report recommended that the EOUST issue national policy directives setting forth (1) minimum standards that UST regions must follow in documenting, assessing, and disposing of fraud allegations against trustees, and (2) guidelines for use by UST personnel to detect fraudulent trustee activities. Among the other findings discussed in the report were:

UST regions were not rigorously following up on correction of trustee deficiencies identified by external reviews,

over one-third of sampled panel trustees submitted incorrect or incomplete semiannual reports, and

the EOUST lacked an effective method for gathering and compiling program statistics to ensure accurate data.

The EOUST implemented the two recommendations by including in the UST Manual the minimum standards for documenting, assessing, and disposing of fraud allegations against trustees and by establishing protocols for regions to follow in dealing with suspected embezzlement and reconstructing the trustee's records.

At the request of the EOUST Director, the Management and Planning Staff (MPS) of the Department's Justice Management Division reviewed UST oversight and management of Chapters 7 and 13. The MPS based its review on interviews at the EOUST and 17 field offices and three other federal agencies. The MPS's October 1999 report, "A Management Review of the U.S. Trustee Program Chapter 7 and 13 Bankruptcy Oversight Processes," stated:

Most staff felt that all [emphasis is original] of the current oversight activities are needed to minimize the risks and were not able to set priorities on efficacy or probability. Disagreement exists on the proper mix of techniques to deter or detect crime and abuse. To figure out the most efficient mix of oversight activities, assessing the risk inherent to the current system is essential and to decide the amount of risk acceptable to USTP [U.S. Trustee Program] managers. The EOUST should conduct a formal analysis of its program risks, along with an assessment of the cost/benefit of certain prevention techniques.

The MPS report also stated the following.

Interviewees were satisfied with existing Chapter 7 oversight activities but suggested some changes such as improved trustee training and more face-to face contact with trustees. Interviewees also suggested changes in UST reviews of trustees' financial reports.

The Chapter 13 process is satisfactory, but some interviewees thought that oversight of case administration and trustees needed improvement. Some respondents said that the program was ripe for fraud and abuse.

Addressing some overarching management concerns would provide significant efficiency gains for Chapters 7 and 13 oversight activities. For example, a more robust and user-friendly information system was needed and there should be greater use of sampling techniques in reviewing trustee reports.

The MPS recommended that the UST Program take the following actions.

Develop an "Anti-Petition Preparer Initiative" that includes creating a national database of petition preparers to aid in the detection of fraudulent activity.

Provide a nationwide database of cases to help in the detection of potential fraud, waste, and abuse.

Obtain the expertise of an outside agency or contractor to conduct a study to determine the amount and extent of debtor fraud in Chapter 7 and 13 bankruptcies, as a key element of risk analysis.

The EOUST has partially implemented the MPS recommendations. Specifically, in January 2002 the EOUST established a petition preparer database tracking system. The database tracking system is discussed in more detail later in this report. The EOUST has not developed a nationwide database of cases to help with the detection of potential fraud, waste, and abuse. However, some regional offices have designed their own tracking systems, both manual and electronic. In one office we audited, the regional staff developed five separate tracking systems to report and track cases. Lastly, at the time of our audit the EOUST had not obtained the expertise of an outside agency or hired a contractor to determine the amount and extent of debtor fraud in Chapters 7 and 13 bankruptcies. As a result, three years after the MPS report UST Program officials told us that they do not know the extent of fraud in the bankruptcy system. Others in the bankruptcy system such as bankruptcy judges, trustees, and national creditor organizations have urged the UST Program to do more to identify fraud because fraud may be increasing with the rise in the number of bankruptcy filings.

Footnotes

The exceptions are the judicial districts of Alabama and North Carolina, which elected to operate a separate bankruptcy administration program.

The maximum allowable trustee compensation is not to exceed 25 percent on the first $5,000 or less, 10 percent on any amount in excess of $5,000 but not in excess of $50,000, 5 percent on any amount in excess of 50,000 but not in excess of $1 million, and reasonable compensation not to exceed 3 percent of such moneys in excess of $1 million, of all moneys disbursed or turned over in the case by the trustee.

A table showing the 21 regional and 95 field offices is included in Appendix 4.

A creditors' committee generally consists of three to eleven unsecured creditors. The creditors' committee may consult with the Program, debtors, and others on matters affecting the administration of the estate.

Creditors may elect Chapter 7 and Chapter 11 trustees.

TFRs and TDRs are reports filed by trustees before and after the distribution of funds to creditors, respectively.

Debtors use bankruptcy schedules to report all assets and liabilities.

The Bankruptcy Courts started requiring that all cases be filed electronically with courts nationwide by the close of FY 2002. Both filing and examining cases are to be done electronically through the internet. The Electronic Case Filing gives the UST Program and others the ability to review the text of all filed documents but does not give the ability to capture and manipulate the information.